Will Transocean Survive the Weakness?

Transocean (RIG) reported its first quarter 2016 results on May 4th. Transocean comprehensively beat revenue and earnings estimates on the back of the cost-cutting measures it employed in response to the weak drillship demand owing to a persistent weakness in commodity prices.

Transocean generated revenue of $ 1.34 billion, down from $ 1.85 billion generated in the previous quarter. However, that meant a beat of $ 200 million.

The adjusted net income earned last quarter was $ 254 million or $ 0.69 per diluted share which was again down from $ 1.68 per share earned in the previous quarter. However, that easily topped the EPS estimates by $ 0.40 per share.

Cost control and Utilization:

Transocean took control of its operating and maintenance expenses and was able to bring them down by 38.7 % year over year to $ 665 million. This was also more than 16 % less than the previous quarter and more than 9 % less than last year’s average spending under this head. This was achieved due to lower activity, cost savings related to operational and restructuring initiatives, and reduced stacking costs for its fifth and sixth generation DP floaters.

The operating margin came in at around 47 % for the quarter, pushed up due to the effect of early contract terminations. That was important as commodity prices are not looking like taking off soon. So, Transocean’s success in containing its expenses by virtue of reduced activity levels as well as other measures to lower expenses related to onshore and offshore operations is worthy of appreciation.

However, Transocean wasn’t able to keep up the rig utilization rate. The rig utilization during Q1 fell to 51 % from 60 % in the preceding quarter and 79 % in the same quarter of the last year. Total average day rates decreased to $ 395,400 in the quarter under review from $ 398,100 in the year-earlier quarter. Significantly lower day rates from a harsh environment and ultra-deepwater floaters led to the decline. Both these parameters were affected to different degrees as a result of the shrinking contract backlog which has slid to $ 14.6 billion as of the company’s most recent fleet status report in April.

With regard to revenue efficiency, Transocean continued to execute well, with the focus on revenue efficiency bearing fruit over the last several quarters. Revenue efficiency for the first quarter was 95 % compared with 95.9 % in the fourth quarter of 2015.

CAPEX, Liquidity, and Debt:

The company spent $ 368 million on capital expenditure in the first quarter. Most of that was associated with payments on the new builds. The company has plans to spend close to $ 1 billion on new builds for the remaining part of this year which is expected to take the total 2016 CAPEX beyond $ 1.1 billion. The new builds will include Deepwater Conqueror, Deepwater Pontus, and Deepwater Poseidon. The CAPEX guidance for 2017 is about $ 625 million.

Cash flow from operations, including a working capital release of $ 128 million, was $ 631 million for the first quarter. For the coming years, several deferrals of new build deliveries and construction contracts will enhance the liquidity position of the company. For instance, the deferral of delivery to Keppel FELS will allow the company to keep $ 735 million more in its hands. Similarly, the deferral of contracts with Jurong to delay delivery of two new build ultra-deepwater drill ships by six months defers approximately $ 420 million from 2019 into 2020. The company had $ 2.6 billion in cash and cash equivalents at the end of Q1. Projected liquidity at the end of 2017 is between $ 4 to 5 billion including the $ 3 billion undrawn revolving credit facility available till mid-2019.

Transocean continued to lower its interest costs by opportunistically repurchasing $ 100 million of debt at a cost of $ 84 million through deals that settled after the end of quarter one. But more importantly, these debt repurchases brought in cash interest savings of approximately $ 23 million over their remaining term. In the last three quarters, the company has repurchased a total debt of $ 603 million at a cost of $ 557 million. The aggregate savings on interest cost due to these repurchases have been approximately $ 105 million through maturity of this debt.

Conclusion

Transocean has improved its operating results and cash position by remaining prudent with its expenditures. It has sufficient backlogs too, but it must be hoping for an increase in new rig demand soon. Unless the market gains more confidence in the supply/demand outlook for floating rigs, the day rates and utilization will prove harder to maintain. For these reasons only, Transocean stock price didn’t pick up despite the positive result and has only little upside unless an extraordinary oil recovery happens.